Preparing Your Investment Portfolio for the Washington State Millionaire’s Tax

Washington’s new personal income tax, widely referred to asthe "Millionaire’s Tax," represents a major tax hurdle forhigh-earning Washington residents. Signed into law by Governor Bob Ferguson, itimposes a flat 9.9% tax on taxable income exceeding $1 million per household.Additionally, many tax and legal experts expect the $1 million exemption to belowered in the future, causing the tax to affect an increasing number ofWashington state residents. On the bright side, there is a two-year window in2026 and 2027 before the tax goes into effect in 2028 to prepare. Although sometaxpayers are considering moving to more tax-friendly states, many do not havethat option or desire to do so. Here are concrete strategies to help prepareyour investment portfolio for the upcoming millionaire’s tax.

How the Millionaire’s Tax Impacts Investment Income

This new tax applies to most forms of taxable income,including wages, profit distributions, dividends, interest, and most capitalgains. The state's existing capital gains tax remains in place, but it allowsfor a deduction of the taxable amount of capital gains against themillionaire's tax, which adds an extra layer of complexity. However, becausethis new tax extends directly to dividends and interest from investments,finding opportunities to shelter and protect your portfolio is vital. Thefollowing strategies can bring significant tax savings when the new regime isimplemented.

Tax Strategies

1. Switch Municipal Bonds to Washington State and Local IssuedBonds

This new tax creates a major structural advantage formunicipal bonds issued by entities based in Washington state. While municipalbond interest is generally exempt from federal tax, current rules dictate thatall out-of-state municipal bond income must be added back to your state taxablebase, subjecting non-local bonds to the additional 9.9% tax for those withincome over $1 million.

By transitioning municipal portfolios away from nationwideissuers and focusing solely on Washington state and local bonds, investors canprotect the municipal portion of their portfolio entirely. There is also timeurgency to this move. As more investors realize this tax-saving opportunity,capital will likely flow heavily into Washington state municipal bonds over thenext several years, pushing yields down. This pattern has already played out inhigh-tax states like California and New York. By acting early, investors havethe opportunity to lock in more attractive yields while they last.

"For high-net-worth investors, switching yourmunicipal bond portfolio to state domiciled issuers should be the biggestaction item from this new tax bill. I cannot understate how impactful thisis."

2. Shift Taxable Income-Producing Investment StrategiesInto Tax-Sheltered Accounts

Different investment strategies carry vastly different taxburdens. Popular income-generating assets, such as dividend-focused stockfunds, corporate bonds, or Treasury bonds, generate annual income that will be subjectto the Washington State income tax. Rebalancing investment accounts to shiftthese income-heavy strategies into tax-sheltered accounts, such as 401(k)s,traditional IRAs, or Roth IRAs, ensures that the income is no longer exposed tothe 9.9% tax. Meanwhile, keeping tax-efficient strategies like growth stocks orlocal municipal bonds in standard taxable accounts creates a well-optimized,tax-aware asset allocation.

3. Utilize More Tax-Efficient Investment Vehicles

In the investment world, vehicle structure matters just asmuch as asset selection. Although three different investment vehicles mighthold the exact same underlying assets and deliver identical gross returns,their net tax efficiency can vary dramatically. The three most commonstructures are Mutual Funds, Exchange-Traded Funds (ETFs), and Direct Indexingor Separately Managed Accounts (SMAs). As a rule of thumb, Direct Indexing andSMAs offer the highest level of tax efficiency, followed by ETFs, with traditionalmutual funds lagging behind due to mandatory capital gain distributions.Transitioning a portfolio into more tax-efficient structures helps minimizeannual tax drag without altering your core investment strategy.

4. Leverage Donor-Advised Funds (DAFs) or CharitableRemainder Trusts (CRTs)

Along with the new income tax comes a strict $100,000 cap onlocal charitable deduction exemptions. For individuals with larger or non-localcharitable goals, utilizing a charitable vehicle like a Donor-Advised Fund(DAF) or a Charitable Remainder Trust (CRT) allows you to secure upfrontfederal tax deductions while realizing capital gains tax-free within thecharitable entity. This approach is particularly effective during high-incomeyears, such as when liquidating a large position in concentrated stock orselling a business.

"For an added bonus, if the DAF or CRT isprincipally managed and directed in the state of Washington, the contributionhas the potential to be used toward the $100,000 charitable deduction limitallowed in the Washington State tax code."

5. Realize Capital Gains Prior to 2028

Because the tax does not take effect until 2028, a strategictwo-year window exists in 2026 and 2027. Certain investors can benefit fromdeliberately realizing capital gains now at current tax rates, avoiding theadditional 9.9% state tax layer that will apply in future years. While gainharvesting requires careful modeling and intentionality, it can yieldsubstantial lifetime tax savings for high-income households. Although there isa refund for the current Washington State capital gains tax under theMillionaires Tax rules, in many scenarios capital gains will end up being taxedat higher rates once this goes into effect.

6. Exercise Stock Options Prior to 2028

For the same reasons described in strategy #5, it may makesense to exercise workplace stock options before 2028. Exercising options witha large bargain element can generate significant taxable income. Beginning in 2028,that income may be subject to Washington State income tax if your householdfalls above the $1,000,000 level. Exercising in 2026 or 2027 effectively avoidsthat additional tax.

Implementing These Strategies

If you believe one of these approaches could benefit yourfinancial situation, work closely with both a knowledgeable CPA and financialadvisor who specializes in Washington state tax planning. David and mypartnership on this article took our combined expertise’s to develop andauthenticate these strategies, and that type partnership is what you shouldlook for when implementing them in coordination with your CPA and financialadvisor. All of these strategies involve added layers of financial, tax, and legalcomplexity beyond what is covered in this article.

Conclusion

This new legislation means investors will retain a smallerportion of their investment returns unless proactive steps are taken. Utilizingthese core strategies will help mitigate the overall impact of the tax. Asadditional tax-efficient structures and planning opportunities emerge, we willcontinue to share updates to help safeguard your wealth.

Authors

Garrett Grigas CFA, CFP® 

Senior Financial Advisor and Managing Partner

Gevers Wealth Management

Garrett@geverswealth.com

David Halfhill CPA

Senior Tax Manager

Sweeney Conrad

dhalfhill@sweeneyconrad.com

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